Industrial

Industrial Stacks Up

Secondary and tertiary markets benefit from key demand drivers.

By Matt Hudgins |

It didn’t take long for Jeff Castell, CCIM, SIOR, to find a buyer for his client’s 704,000-square-foot distribution center in Franklin, Ind., earlier this year. A principal at Cassidy Turley in Indianapolis, Castell knew the property’s 32-foot clear heights and massive size fit the needs of today’s most active industrial users. And with his client planning to vacate the space after the sale, there was an opportunity to capitalize on user demand in this suburb on the south side of Indianapolis, which is one of the most sought-after markets for distribution centers in the country.

Castell’s team identified a tenant, Anderson Merchandisers, to take the entire space, and, based on that lease, was able to sell the property in March to a joint venture of Alex. Brown Realty and Biynah Industrial Partners. Less than a month later, the joint venture sold the property again, to Stag Industrial, for a staggering $18 million or nearly $25 per sf.

Midwest in Demand

The transactions underscore the brisk pace and healthy pricing of both leasing and investment deals today in the Midwest industrial markets, and particularly in Indianapolis, where proximity to large population centers and resurgent manufacturing is driving demand. “There’s a combination of continued demand and lack of product in central Indiana,” says Castell. “As a result, we’ve got between 3 million and 3.5 million sf of speculative construction under way right now.”

Industrial Developments International is developing one of those speculative projects, an 800,000-sf distribution building at AmeriPlex Business Park, next to Indianapolis International Airport, says the company’s broker, Jeremy Woods, CCIM, SIOR. The industrial vacancy rate in Indianapolis is 7 percent overall and a scant 5 percent for the most modern space, according to Woods, who is executive vice president at Summit Realty Group in Indianapolis. Historically, the market’s vacancy rate has averaged about 14 percent. “We are at an unprecedented low vacancy rate in that modern bulk space,” Woods says.

The tight market stems from a banner leasing year in 2008, when the market absorbed about 8 million sf of industrial space at the same time that speculative construction came to a halt. Absorption has continued to eat away at available space ever since, as companies have taken Indianapolis buildings in order to consolidate their supply chains and reduce costs, Woods says.

What is Indianapolis’ secret to success? In addition to the city’s geographic advantage for supply chain hubs, recently passed right-to-work legislation has increased Indiana’s appeal to corporate users seeking affordable skilled workers, Castell says.

The availability of non-union, skilled labor is also helping to drive demand for manufacturing space in western Michigan, says Duke Suwyn, CCIM, SIOR, president and CEO of Colliers International in Grand Rapids, Mich. The most active leasing activity of late has involved manufacturers of food and specialized automotive parts, but makers of pharmaceuticals and other specialized, low-volume products are also taking space.

“We’re in a crazy situation here — we are out of inventory and we have very strong demand for space,” Suwyn says. In July, one of Suwyn’s clients received final approval to develop an 85,000-sf structure for light manufacturing and distribution uses in Kentwood, Mich., in a build-to-suit for an undisclosed user. “That will be the first new standalone industrial construction we’ve seen in years,” he says.

A Nation Recovers

The Midwest is perhaps the brightest spot among industrial markets in 2012, but it isn’t alone. The U.S. industrial market showed marked strength at midyear, with a net 22.5 million sf of space absorbed by tenants in the second quarter, according to New York-based research firm Reis. The national vacancy rate ended the quarter at 13 percent, down 30 basis points from the first quarter and down 80 basis points from a year earlier.

“The second quarter was the strongest quarter we’ve seen in the past year,” says Brad Doremus, Reis’ senior analyst. “Rents were also the highest we’ve seen them grow since one year ago as well.”

Asking annual industrial rent averaged $5.35 psf in the second quarter and was up 0.5 percent from the first quarter, Reis reports. Effective rent, which factors in incentives, was $4.81 psf, up 0.6 percent from the previous quarter. “Incentives have started to tighten, which is a good sign for owners,” Doremus says.

He attributes the healthy occupancy numbers in part to a remarkably small supply of new construction in the pipeline. Developers delivered just 2.3 million sf of industrial space in the second quarter, down from 2.5 million sf in the first quarter. “We’re seeing some of the lowest construction figures we have ever seen,” he says.

Industrial Hot Spots

Manufacturing and a resurgent automotive industry is fueling leasing activity in the Midwest, Doremus confirms, and seaport activity is driving up occupancy and rental rates all along the West Coast. Absorption is increasing in the Mid-Atlantic markets of Atlanta and Raleigh/Durham, N.C., and even in Tampa, Fla., all of which may be benefiting from the pending expansion of the Panama Canal, Doremus speculates.

Here are a few of the trends generating deals today, based on a recent survey of CCIMs.

Denver is a great place to live, and businesses that support its growing population are driving industrial demand there. Vacancy is less than 10 percent, according to Steve Poole, CCIM, vice president of industrial sales at Cassidy Turley Fuller Real Estate in Denver.

From Denver northward, a thriving oil and gas industry has soaked up nearly all of the older industrial stock, says Mark Bradley, CCIM, SIOR, managing broker of Realtec Greeley in Greeley, Colo. Exploration companies and venders serving the sector are chiefly interested in industrial buildings they can drive a truck into, with plenty of space for truck courts and outdoor storage. “Our vacancy rate has gone from 18 percent or so a year ago to 7 percent or 8 percent right now,” Bradley says. “Absorption has been strong all along the Highway 85 corridor from North Denver to Wyoming.”

In Texas, industrial demand is strong in the Tarrant County area to serve industries ranging from automobiles to call centers, food, importers, and security, says Jennifer Gray, CCIM, broker and managing partner for Northeast Tarrant and Denton counties at Bradford Commercial Real Estate Services in Southlake, Texas.

Shannon Owens, CCIM, vice president of Glacier Commercial Realty in Irving, Texas, says a number of companies new to North Texas are leasing spaces from 20,000 sf to 30,000 sf while they test the market. Many of her technology and engineering clients have doubled their headcounts and square footage over the past 18 months to handle increased business.

And in California’s Inland Empire, manufacturers are taking space as a more affordable alternative to properties in Los Angeles, where port-related demand keeps lease rates at a premium, reports Tony Guglielmo, CCIM, broker/owner of Allied Commercial Real Estate in Ontario, Calif.

Challenged Markets

Many markets that entered the recession with an overhang of space continue to struggle with weak demand and anemic rental rates. Lease rates are down 20 percent or more from their peak in Goshen, Ind., according to Steve Pettit, CCIM, senior associate broker at CB Richard Ellis|Bradley. In Columbus, Ohio, it is still a tenant’s market due to a space glut, reports Kevin McGrath, CCIM, associate vice president at Cassidy Turley in that city.

A chicken-and-egg dilemma is hampering industrial development in the Carolinas, brokers say. Both Brooke Gibson, CCIM, broker at Hart Corp.|International Industrial Real Estate in Charlotte, N.C., and Mike Ferrer, CCIM, vice president for industrial brokerage at Avison Young in Mount Pleasant, S.C., say there is a shortage of modern distribution space in their markets. Yet banks won’t fund speculative construction to meet that need, and tenants are reluctant to commit to space before it is built.

Atlanta may be hardest hit industrial market in the nation as it struggles with an oversupply and weak demand, says Rick Tumlin, CCIM, SIOR, senior partner at Lee & Associates in that market.

Indeed, the recent uptick in industrial demand is a shadow of what it was in healthier years, with the number of retailers seeking industrial space down about 60 percent since 2008, according to Paul Waters, CCIM, SIOR, FRICS, executive managing director of industrial brokerage for the Americas at NAI Global in New York City. Waters works with major corporate end users of industrial space and currently is helping a discount retailer re-engineer its supply chain by developing a half-dozen large distribution centers around the country.

Of the few corporations seeking industrial buildings, most prefer large, modern buildings measuring 450,000 sf to 1 million sf. “And in most cases, they’re looking to build,” Waters says, adding that companies can take advantage of favorable market conditions to construct space that fits their needs exactly rather than adapt to existing digs in most markets.

Waters doesn’t paint a rosy picture for 2013, either, predicting that demand for space will continue near current levels until employment improves and boosts consumer spending. “We need to put people back to work so they can buy things that retailers sell,” he says. “People are expecting great changes after the [November] election, but I don’t see any change coming for industrial next year.”

But Doremus, the Reis analyst, is optimistic about 2013, trusting that once the markets move past the uncertainties of 2012, companies will adjust to conditions at home and abroad and make more real estate decisions. That means absorption will accelerate, and rents will rise soon after.

Matt Hudgins is a real estate business writer based in Austin, Texas.

Industrial Investors Gravitate to Secondary Markets

Investors are increasingly seeking high-quality industrial assets in second-tier cities as an alternative to acquiring properties in primary markets where bidding wars have driven prices to unpalatable levels, CCIMs tell CIRE.

In primary industrial markets like Chicago, investors are buying fully leased, well-located class A properties at less than a 6 percent capitalization rate, according to Kenneth Szady, CCIM, SIOR, executive managing director and head of the Midwest Capital Group at Newmark Grubb Knight Frank in Chicago.

When cap rates fall below that 6 percent threshold, investors begin to either look for lower quality or less well-located assets in the primary markets, or they begin shopping for class A properties in secondary markets, Szady says. In either case, those investors will acquire assets in a cap rate range from 7.5 percent to 8.5 percent.

That’s based on Szady’s experience over a 24-year career in which he has closed $7.2 billion in transactions, including two of the largest deals of 2012. This past summer, he represented the Gullo family in selling a 330,000-square-foot industrial portfolio in Elk Grove Village, Ill., near O’Hare International Airport, to Morgan Stanley. In March, he closed a 1.35 million-sf build-to-suit transaction for the Clorox Co. in University Park, Ill., on behalf of an institutional client. (Szady was executive director and head of capital markets at Cushman & Wakefield at the time of the March deal).

Indeed, CCIMs in secondary markets with low vacancy rates, including Indianapolis, northern Colorado, Texas, and other markets with expanding regional economies, report strong investor interest in industrial properties. “Yields look pretty good here especially when coupled with the excellent story Indy can tell,” says Jeremy Woods, CCIM, SIOR, executive vice president of Summit Realty Group in Indianapolis. “We are also seeing an appetite for class B value-add properties as the newer, more modern space is beginning to get frothy.”

At least for the next year or two — until construction can introduce new supply to the primary markets — investors will be active buyers in the secondary markets, Szady predicts. “We’re just opening the floodgates into the secondary markets,” he says, “and it’s the beginning of the cycle.”